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    Basel 3 Banking Guidelines Thrust Gold into the Spotlight

    What is Basel 3 and how does it affect gold investors? That is what we examine in today’s article. I will show how the new requirements for banks are going to help the value of the gold you hold in your portfolio. First things first, let us define what Basel 3 is. Per Delphix:

    “Basel 3 is a set of international banking regulations developed by the Bank for International Settlements in order to promote stability in the international financial system. Basel III regulation is designed to decrease damage done to the economy by banks that take on too much risk.”

    Development of Basel 3 Banking Guidelines

    Basel 3 guidelines were passed after the 2008-09 financial crisis known better as the Great Recession. The Great Recession stands as the largest economic crash in the US since the Great Depression in the 1930s. We learned from the crisis that the banking system lacked sufficient liquidity to deal with an overheated mortgage market where much of the mortgage paper was built on inadequate borrower profiles that lacked sufficient income and reserves to service mortgage loans.

    In other words, it was a Ponzi system built on inadequate funding. And what the regulators and bankers figured out is they need to have more liquidity in the system to deal with severe downturns in major markets which may cause fund flows to dry up and threaten the banking system. After all, modern banking runs on liquidity. When the funds dry up, companies don’t have capital and neither do individuals.

    And in today’s financial system, liquidity drying up is also an existential threat to the system remaining afloat. That is because currency is created through the issuance of debt and the currency needs to be constantly created and flowing to service that debt. Specifically, Basel 3 requires the following:

    “The Basel III accord increased the minimum Basel III capital requirements for banks from 2% in Basel II to 4.5% of common equity, as a percentage of the bank’s risk-weighted assets. There is also an extra 2.5% buffer capital requirement that brings the total minimum requirement to 7% in order to be Basel compliant. Banks can use the buffer when they face financial stress, but using the buffer can lead to even more financial constraints when paying dividends.

    In 2015, the Tier I capital requirement increased from 4% in Basel II to 6% in Basel III. The 6% includes 4.5% of Common Equity Tier 1 and an additional 1.5% of additional Tier 1 capital. The requirements were originally meant to be implemented starting in 2013, but banks now have until January 1, 2022, to implement the changes.”

    Personally, I do not think that these capital requirements changes are going to solve the issue of a banking system that is one crisis away from reaching systemic risk, much like they did 14 years ago. The capital requirements are not robust enough to stop a similar situation as we experience with the mortgage market and Lehman.

    That being said, I would never downplay the importance of having liquid capital reserves during regular business cycle downturns. The question is whether the new requirements will be enough to steady the system in times of heavy stress, such as during a major recession. We have not had one since the new requirements were established, so time will tell how well the bankers designed the new system.

    Basel 3 and the Value of Gold

    So what does this mean for gold? Part of the Basel 3 requirements is defining High Quality Liquid Assets (HQLA). These are assets that are considered the highest quality in the banking system and will be used as part of the additional capital requirements of Basel 3. The fun part of the story is that gold has been explicitly defined as an HQLA in the system (as long as hedged in futures markets), and will therefore be a VERY important part of the new banking system.

    In a previous article, I pointed out that the central banks had been on a run buying gold, culminating in a major boost in purchases during the last quarter that was the largest since 1967. That’s right, the largest in 55 years! See picture below for an idea of how high gold purchases have spiked dating back 12 years.

     

     

    The reason banks are purchasing gold is simple – the banks consider it to be one of the world’s most stable and high value assets to the point they are using it to capitalize the commercial banking system! Despite what your local broker may tell you, gold is an extremely valuable financial asset recognized as the highest quality in the land by the top experts in the monetary system.

    So next time your brother-in-law criticizes you for buying precious metals at Thanksgiving dinner, just point them to this article and explain how the smartest financial minds in the world are buying it hand over fist. And then point him to JM Bullion to make his next bullion purchase.

    Final Thoughts

    I believe it is very possible that as we get closer to the next financial collapse, which I don’t expect to be too long now, that banks and financial houses rush into the gold market and buy up whatever metal liquidity they can find. In fact, buying could be much higher this time because I expect the dollar and US bond system to come under extreme pressure during the next financial crisis.

    The next crisis will call into question the validity of the dollar as the global reserve currency. With China and Russia developing a global fiat money alternative, it is quite possible that the banking system will bifurcate along currency lines and not purchase dollars and dollar denominated debt this time around. If that happens, the likely landing place for their safety nets will be in gold and silver.

    But, there won’t be enough silver which has been hurtling towards a shortage scenario. There simply will not be enough silver to satisfy sovereign and financial system requirements. I expect gold to get bid up significantly at this point, and will certainly benefit the current holders. This is yet another reason to look at gold for your portfolio. The wisest financial minds in banking have already been doing this for a decade.

     

     

     

    Disclaimer: All Market Updates are provided as a third party analysis and do not necessarily reflect the explicit views of JM Bullion Inc. and should not be construed as financial advice.

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